During July, the risks facing South African consumers increased immediately after producer inflation came in worse than expected at 7,5% from just 5,9% in May. This set the cat among the pigeons and increased the likelihood of higher rate increases in the current tightening cycle, but the South African Reserve Bank (SARB) needs to be cautious in not adopting a too-tight monetary policy in the current environment, where inflation is not just a demand side phenomenon.
July was the first full month since June’s rate hike in which the private sector faced higher interest rates and it will be interesting to see to what extent the 50-basis-point hike dampened credit demand when the numbers are released in late August.
The monetary policy committee (MPC) will surely want to ensure that consumers, the primary drivers of growth in the past number of years, experience a soft landing.
Raising interest rates will provide some support for the rand and, by dampening domestic consumer spending, could alleviate some pressure from the imported component of inflation. However, oil prices remain of concern in this time of global instability and, given that domestic inflation is not primarily a demand-side phenomenon at present, the SARB should be cautious in adopting too tight a monetary policy in the current environment.
On the positive side, the country had a more resilient rand towards the end of July, but the key concerns remain inflation and credit demand going forward.
A rate hike at the August MPC meeting on Thursday seems certain, but the timing of further interest-rate movements going forward hinges on the global inflation outlook, the value of the rand and international interest-rate movements.
M3 money supply growth continued to grow strongly in June and although lower than May’s 24,2%, and slightly below market expectations, June’s year-on-year M3 growth, at 23,07%, remains high.
PSCE growth of 23.89% in June was above market expectations and indicates continued strong demand for credit by the private sector, despite an increase in interest rates in June. Having topped 20% for five consecutive months now, policymakers will be aware of the potential inflationary impact of excess liquidity in the economy and high credit demand.
CPI growth for June was 4,9% year-on-year, while CPIX was 4,8%, the highest in a year. However, underlying inflation, which excludes all food, housing and vehicle costs, actually fell year-on-year to 1,9% from 2,1% in May.
This is a clear indication that second-round inflation remains subdued.
June’s PPI inflation, however, was well higher than market expectations, increasing year-on-year in June to 7,5%, up 1,6 percentage points from May’s 5,9%. PPI increased by a massive 3% month-on-month.
Higher producer price increases for June are confirmation of the stronger inflationary environment in the productive side of the economy, borne out in the high prices sub-index of the July Investec purchasing managers index (PMI). As with the CPI data, the PPI data showed a material worsening of inflation pressures.
Consumer spending continued into the second quarter virtually unabated, as real retail sales grew by 9,7% in April, above the average year-on-year growth of 9,4% for the first quarter of 2006. With prime still at 10,5% and private-sector credit demand remaining strong in May, retail sales for May are likely to have remained strong.
After April’s very poor manufacturing performance, it was reassuring to see manufacturing production growth increase to 5,1% year-on-year for May. The month’s figures certainly will reassure those analysts who feared that April’s weak growth was the start of a reversal of fortunes in the sector.
The seasonally adjusted Investec PMI rose for the fifth successive month, from May’s 57,6 to 59,8 in June. The biggest drivers of this rise in the PMI were increases in new sales orders, rising from 63,7 to 65,7; prices, rising from 68,8 to 77,3; and employment, rising strongly from 50,3 to 56,1. Strong growth in these areas may be indicating that the domestic economy is entering a period of higher production-side growth and inflation.
Bonds had a somewhat volatile month in July. While the CPI numbers were in line with market expectations, PPI inflation was an adverse shock to the market, coming in at 7,5% compared with the market expectation of 6,3%. The yield curve, which had been steepening, started to flatten again as short-term bond yields shot up higher than longer-dated paper.
The strengthening of the rand late in the month and the lower-than-expected growth of second-quarter United States GDP are expected to be positive for local bonds going into August. The US GDP figures were much lower than expected and US bond yields fell in response, as the US interest-rate cycle is expected to be close to its peak. South African bond yields should moved lower, in tandem with the movements in US bonds.
Taking all of the above into account, a survey by I-Net Bridge found during the course of the month that economists were increasing their forecasts for the current interest-rate-tightening cycle upwards, with the majority of economists expecting increases of 150 basis points. The consensus for the entire tightening cycle was at 150 basis points, with seven of the 13 economists surveyed preferring this outlook.
Views varied regarding the length and extent of the current tightening cycle, with forecasts ranging from 75 to 200 basis points (with economists at 75 basis points saying they wanted to review this once more data became available).
The highest forecast for the tightening cycle was at 200 basis points, with four of the 13 economists surveyed forecasting this range (which includes the 50 basis-point increase on June 8). — I-Net Bridge